Morningstar equity analysts have raised their fair value estimate for BHP Billiton (BLT) to £12.70 because of an expected rise in commodity prices. In a production update this week, the mining giant forecast a drop in its iron ore output this financial year because of unplanned maintenance. But the price of iron ore has been surging in recent weeks after moves by China to relax lending rules, so analysts expect this price gain to make up for the production shortfall.
The bulk of our BHP Billiton fair value estimate derives from just three commodities: iron ore, copper, and petroleum. Our price scenarios also factor in currency, operating, and capital cost adjustments.
In our bull case, we expect commodity prices to increase by 15%. Our fair value estimate in this scenario is £16.50 a share, against a current price in London of £15.30. In our bear-case scenario, we project prices to fall by 15%. Our bear-case fair value estimate falls to 800p a share.
We think the attractive forecast 2018 earnings and returns are fuelled by favourable commodity prices, underpinned by unsustainable growth in China’s debt, and more recently trade unrest. While trade sanctions may restrict global commodity supply in the near-term, longer-term those assets are productive and likely to continue to contribute.
BHP’s production guidance for the 2018 financial year is retained for petroleum, metallurgical coal and energy coal, while the range was narrowed for copper. Iron ore output was softer than expected and BHP has lowered guidance by approximately 2% to 272 to 274 million tonnes.
However, higher commodity prices more than make up for the short fall. Plans to exit US onshore petroleum assets continue to progress. There were no major changes on the capital expenditure front and we still expect the large diversified miners to remain frugal with new expenditure in the near to medium term.
